Thursday, September 29, 2011

Public finance - part 2

Public finance through state enterprise
Further information: State-owned enterprise
Public finance in centrally planned economies has differed in fundamental ways from that in market economies. Some state-owned enterprises generated profits that helped finance government activities. The government entities that operate for profit are usually manufacturing and financial institutions, services such as nationalized healthcare do not operate for a profit to keep costs low for consumers. The Soviet Union relied heavily on turnover taxes on retail sales. Sales of natural resources, and especially petroleum products, were an important source of revenue for the Soviet Union.
In market-oriented economies with substantial state enterprise, such as in Venezuela, the state-run oil company PSDVA provides revenue for the government to fund its operations and programs that would otherwise be profit for private owners. In various mixed economies, the revenue generated by state-run or state-owned enterprises are used for various state endeavors; typically the revenue generated by state and government agencies goes into a sovereign wealth fund. An example of this is the Alaska Permanent Fund and Singapore's Temasek Holdings.
Various market socialist systems or proposals utilize revenue generated by state-run enterprises to fund social dividends, eliminating the need for taxation altogether.

Government Finance Statistics and Methodology
Macroeconomic data to support public finance economics are generally referred to as fiscal or government finance statistics (GFS). The Government Finance Statistics Manual 2001 (GFSM 2001) is the internationally accepted methodology for compiling fiscal data. It is consistent with regionally accepted methodologies such as the European System of Accounts 1995 and consistent with the methodology of the System of National Accounts (SNA1993) and broadly in line with its most recent update, the SNA2008.

Challenges in measuring government
The size of governments, their institutional composition and complexity, their ability to carry out large and sophisticated operations, and their impact on the other sectors of the economy warrant a well-articulated system to measure government economic operations.
The GFSM 2001 addresses the institutional complexity of government by defining various levels of government. The main focus of the GFSM 2001 is the general government sector defined as the group of entities capable of implementing public policy through the provision of primarily nonmarket goods and services and the redistribution of income and wealth, with both activities supported mainly by compulsory levies on other sectors. The GFSM 2001 disaggregates the general government into subsectors: central government, state government, and local government. The concept of general government does not include public corporations. The general government plus the public corporations comprise the public sector.
The GFSM 2001 framework is similar to the financial accounting of businesses. For example, it recommends that governments produce a full set of financial statements including the statement of government operations (akin to the income statement), the balance sheet, and a cash flow statement. Two other similarities between the GFSM 2001 and business financial accounting are the recommended use of accrual accounting as the basis of recording and the presentations of stocks of assets and liabilities at market value. It is an improvement on the prior methodology - Government Finance Statistics Manual 1986 – based on cash flows and without a balance sheet statement.

Users of GFS
The GFSM 2001 recommends standard tables including standard fiscal indicators that meet a broad group of users including policy makers, researchers, and investors in sovereign debt. Government finance statistics should offer data for topics such as the fiscal architecture, the measurement of the efficiency and effectiveness of government expenditures, the economics of taxation, and the structure of public financing. The GFSM 2001 provides a blueprint for the compilation, recording, and presentation of revenues, expenditures, stocks of assets, and stocks of liabilities. The GFSM 2001also defines some indicators of effectiveness in government’s expenditures, for example the compensation of employees as a percentage of expense. The GFSM 2001 includes a functional classification of expense as defined by the Classification of Functions of Government (COFOG) .
This functional classification allows policy makers to analyze expenditures on categories such as health, education, social protection, and environmental protection. The financial statements can provide investors with the necessary information to assess the capacity of a government to service and repay its debt, a key element determining sovereign risk, and risk premia. Like the risk of default of a private corporation, sovereign risk is a function of the level of debt, its ratio to liquid assets, revenues and expenditures, the expected growth and volatility of these revenues and expenditures, and the cost of servicing the debt. The government’s financial statements contain the relevant information for this analysis.
The government’s balance sheet presents the level of the debt; that is the government’s liabilities. The memorandum items of the balance sheet provide additional information on the debt including its maturity and whether it is owed to domestic or external residents. The balance sheet also presents a disaggregated classification of financial and non-financial assets.
These data help estimate the resources a government can potentially access to repay its debt. The statement of operations (“income statement”) contains the revenue and expense accounts of the government. The revenue accounts are divided into subaccounts, including the different types of taxes, social contributions, dividends from the public sector, and royalties from natural resources. Finally, the interest expense account is one of the necessary inputs to estimate the cost of servicing the debt.

Fiscal Data Using the GFSM 2001 Methodology
GFS can be accessible through several sources. The International Monetary Fund publishes GFS in two publications: International Financial Statistics and the Government Finance Statistics Yearbook. The World Bank gathers information on external debt. On a regional level, the Organization for Economic Co-operation and Development (OECD) compiles general government account data for its members, and Eurostat, following a methodology compatible with the GFSM 2001, compiles GFS for the members of the European Union.

Public finance - part 1

Public finance is the revenue and expenditure of public authorities

The purview of public finance is considered to be threefold: governmental effects on (1) efficient allocation of resources, (2) distribution of income, and (3)macroeconomic stabilization.

The proper role of government provides a starting point for the analysis of public finance. In theory, under certain circumstances private markets will allocate goods and services among individuals efficiently (in the sense that no waste occurs and that individual tastes are matching with the economy's productive abilities). If private markets were able to provide efficient outcomes and if the distribution of income were socially acceptable, then there would be little or no scope for government. In many cases, however, conditions for private market efficiency are violated. For example, if many people can enjoy the same good at the same time (non-rival, non-excludable consumption), then private markets may supply too little of that good. National defense is one example of non-rival consumption, or of a public good.
"Market failure" occurs when private markets do not allocate goods or services efficiently. The existence of market failure provides an efficiency-based rationale for collective or governmental provision of goods and services. Externalities, public goods, informational advantages, strong economies of scale, and network effects can cause market failures. Public provision via a government or a voluntary association, however, is subject to other inefficiencies, termed "government failure."
Under broad assumptions, government decisions about the efficient scope and level of activities can be efficiently separated from decisions about the design of taxation systems (Diamond-Mirlees separation). In this view, public sector programs should be designed to maximize social benefits minus costs (cost-benefit analysis), and then revenues needed to pay for those expenditures should be raised through a taxation system that creates the fewest efficiency losses caused by distortion of economic activity as possible. In practice, government budgeting or public budgeting is substantially more complicated and often results in inefficient practices.
Government can pay for spending by borrowing (for example, with government bonds), although borrowing is a method of distributing tax burdens through time rather than a replacement for taxes. Adeficit is the difference between government spending and revenues. The accumulation of deficits over time is the total public debt. Deficit finance allows governments to smooth tax burdens over time, and gives governments an important fiscal policy tool. Deficits can also narrow the options of successor governments.
Public finance is closely connected to issues of income distribution and social equity. Governments can reallocate income through transfer payments or by designing tax systems that treat high-income and low-income households differently.
The Public Choice approach to public finance seeks to explain how self-interested voters, politicians, and bureaucrats actually operate, rather than how they should operate.

Public finance management
Collection of sufficient resources from the economy in an appropriate manner along with allocating and use of these resources efficiently and effectively constitute good financial management. Resource generation, resource allocation and expenditure management (resource utilization) are the essential components of a public financial management system.
Public Finance Management (PFM) basically deals with all aspects of resource mobilization and expenditure management in government. Just as managing finances is a critical function of management in any organization, similarly public finance management is an essential part of the governance process. Public finance management includes resource mobilization, prioritization of programmes, the budgetary process, efficient management of resources and exercising controls. Rising aspirations of people are placing more demands on financial resources. At the same time, the emphasis of the citizenry is on value for money, thus making public finance management increasingly vital.

Government expenditures
Main article: Government spending
Economists classify government expenditures into three main types. Government purchases of goods and services for current use are classed as government consumption. Government purchases of goods and services intended to create future benefits--- such as infrastructure investment or research spending--- are classed as government investment. Government expenditures that are not purchases of goods and services, and instead just represent transfers of money--- such as social security payments--- are called transfer payments.

Government operations
Main article: Government operations
Government operations are those activities involved in the running of a state or a functional equivalent of a state (for example, tribes, secessionist movements or revolutionary movements) for the purpose of producing value for the citizens. Government operations have the power to make, and the authority to enforce rules and laws within a civil, corporate, religious, academic, or otherorganization or group. In its broadest sense, "to govern" means to rule over or supervise, whether over a state, a set group of people, or a collection of people.

Income distribution
Main article: Income distribution
§  Income distribution - Some forms of government expenditure are specifically intended to transfer income from some groups to others. For example, governments sometimes transfer income to people that have suffered a loss due to natural disaster. Likewise, public pension programs transfer wealth from the young to the old. Other forms of government expenditure which represent purchases of goods and services also have the effect of changing the income distribution. For example, engaging in a war may transfer wealth to certain sectors of society. Public educationtransfers wealth to families with children in these schools. Public road construction transfers wealth from people that do not use the roads to those people that do (and to those that build the roads).

Financing of government expenditures
Main article: Government revenue
Government expenditures are financed in two ways:
§  Taxes
How a government chooses to finance its activities can have important effects on the distribution of income and wealth (income redistribution) and on the efficiency of markets (effect of taxes on market prices and efficiency). The issue of how taxes affect income distribution is closely related to tax incidence, which examines the distribution of tax burdens after market adjustments are taken into account. Public finance research also analyzes effects of the various types of taxes and types of borrowing as well as administrative concerns, such as tax enforcement.

Main article: Tax
Taxation is the central part of modern public finance. Its significance arises not only from the fact that it is by far the most important of all revenues but also because of the gravity of the problems created by the present day heavy tax burden. The main objective of taxation is raising revenue. A high level of taxation is necessary in a welfare State to fulfill its obligations. Taxation is used as an instrument of attaining certain social objectives i.e. as a means of redistribution of wealth and thereby reducing inequalities. Taxation in a modern Government is thus needed not merely to raise the revenue required to meet its ever-growing expenditure on administration and social services but also to reduce the inequalities of income and wealth. Taxation is also needed to draw away money that would otherwise go into consumption and cause inflation to rise.
A tax is a financial charge or other levy imposed on an individual or a legal entity by a state or a functional equivalent of a state (for example, tribes, secessionist movements or revolutionarymovements). Taxes could also be imposed by a subnational entity. Taxes consist of direct tax or indirect tax, and may be paid in money or as corvée labor. A tax may be defined as a "pecuniary burden laid upon individuals or property to support the government [ . . .] a payment exacted by legislative authority." A tax "is not a voluntary payment or donation, but an enforced contribution, exacted pursuant to legislative authority" and is "any contribution imposed by government [ . . .] whether under the name of toll, tribute, tallage, gabel, impost, duty, custom, excise, subsidy, aid, supply, or other name."
§  There are various types of taxes, broadly divided into two heads - direct (which is proportional) and indirect tax (which is differential in nature):
§  Stamp duty, levied on documents
§  Excise tax (tax levied on production for sale, or sale, of a certain good)
§  Sales tax (tax on business transactions, especially the sale of goods and services)
§  Value added tax (VAT) is a type of sales tax
§  Services taxes on specific services
§  Road tax; Vehicle excise duty (UK), Registration Fee (USA), Regco (Australia), Vehicle Licensing Fee (Brazil) etc.
§  Gift tax
§  Duties (taxes on importation, levied at customs)
§  Personal income tax (may be levied on individuals, families such as the Hindu joint family in India, unincorporated associations, etc.)

Main article: Government debt
Governments, like any other legal entity, can take out loans, issue bonds and make financial investments. Government debt (also known as public debt or national debt) is money (or credit) owed by any level of government; either central or federal government,municipal government or local government. Some local governments issue bonds based on their taxing authority, such as tax increment bonds or revenue bonds.
As the government represents the people, government debt can be seen as an indirect debt of the taxpayers. Government debt can be categorized as internal debt, owed to lenders within the country, and external debt, owed to foreign lenders. Governments usually borrow by issuing securities such as government bonds and bills. Less creditworthy countries sometimes borrow directly fromcommercial banks or international institutions such as the International Monetary Fund or the World Bank.
Most government budgets are calculated on a cash basis, meaning that revenues are recognized when collected and outlays are recognized when paid. Some consider all government liabilities, including future pension payments and payments for goods and services the government has contracted for but not yet paid, as government debt. This approach is called accrual accounting, meaning that obligations are recognized when they are acquired, or accrued, rather than when they are paid.


Main article: Seigniorage
Seigniorage is the net revenue derived from the issuing of currency. It arises from the difference between the face value of a coin or bank note and the cost of producing, distributing and eventually retiring it from circulation. Seigniorage is an important source of revenue for some national banks, although it provides a very small proportion of revenue for advanced industrial countries.

Wednesday, September 28, 2011

Personal finance

Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. It addresses the ways in which individuals or families obtain, budget, save, and spend monetary resources over time, taking into account various financial risks and future life events. Components of personal finance might include checking and savings accounts, credit cards and consumer loans, investments in the stock market, retirement plans, social security benefits, insurancepolicies, and income tax management.

Personal financial planning

A key component of personal finance is financial planning, which is a dynamic process that requires regular monitoring and reevaluation. In general, it has five steps:
1.   Assessment: One's personal financial situation can be assessed by compiling simplified versions of financial balance sheets and income statements. A personal balance sheet lists the values of personal assets (e.g., car, house, clothes, stocks, bank account), along with personal liabilities (e.g., credit card debt, bank loan, mortgage). A personal income statement lists personal income and expenses.
2.   Setting goals: Two examples are "1. Retire at age 65 with a personal net worth of $1,000,000," and, "2. Buy a house in 3 years while paying a monthly mortgage servicing cost that is no more than 25% of my gross income." Having multiple goals is common, including a mix of short term and long term goals. Setting financial goals helps to direct financial planning.
3.   Creating a plan: The financial plan details how to accomplish your goals. It could include, for example, reducing unnecessary expenses, increasing one's employment income, or investing in the stock market.
4.   Execution: Execution of one's personal financial plan often requires discipline and perseverance. Many people obtain assistance from professionals such as accountants, financial planners, investment advisers, and lawyers.
5.   Monitoring and reassessment: As time passes, one's personal financial plan must be monitored for possible adjustments or reassessments.
Typical goals most adults have are paying off credit card and/or student loan debt, investing for retirement, investing for college costs for children, paying medical expenses, and planning for passing on their property to their heirs (which is known as estate planning).

The six key areas of personal financial planning, as suggested by the Financial Planning Standards Board, are:
1 - Financial Position: this area is concerned with understanding the personal resources available by examining net worth and household cash flow. Net worth is a person's balance sheet, calculated by adding up all assets under that person's control, minus all liabilities of the household, at one point in time. Household cash flow totals up all the expected sources of income within a year, minus all expected expenses within the same year. From this analysis, the financial planner can determine to what degree and in what time the personal goals can be accomplished.
2 - Adequate Protection: the analysis of how to protect a household from unforeseen risks. These risks can be divided into liability, property, death, disability, health and long term care. Some of these risks may be self-insurable, while most will require the purchase of an insurance contract. Determining how much insurance to get, at the most cost effective terms requires knowledge of the market for personal insurance. Business owners, professionals, athletes and entertainers require specialized insurance professionals to adequately protect themselves. Since insurance also enjoys some tax benefits, utilizing insurance investment products may be a critical piece of the overall investment planning.
3 - Tax Planning: typically the income tax is the single largest expense in a household. Managing taxes is not a question of if you will pay taxes, but when and how much. Government gives many incentives in the form of tax deductions and credits, which can be used to reduce the lifetime tax burden. Most modern governments use a progressive tax. Typically, as your income grows, you pay a higher marginal rate of tax. Understanding how to take advantage of the myriad tax breaks when planning your personal finances can make a significant impact upon your success.
4 - Investment and Accumulation Goals: planning how to accumulate enough money to acquire items with a high price is what most people consider to be financial planning. The major reasons to accumulate assets is for the following: a - purchasing a house b - purchasing a car c - starting a business d - paying for education expenses e - accumulating money for retirement, to generate a stream of income to cover lifestyle expenses.
Achieving these goals requires projecting what they will cost, and when you need to withdraw funds. A major risk to the household in achieving their accumulation goal is the rate of price increases over time, or inflation. Using net present value calculators, the financial planner will suggest a combination of asset earmarking and regular savings to be invested in a variety of investments. In order to overcome the rate of inflation, the investment portfolio has to get a higher rate of return, which typically will subject the portfolio to a number of risks. Managing these portfolio risks is most often accomplished using asset allocation, which seeks to diversify investment risk and opportunity. This asset allocation will prescribe a percentage allocation to be invested in stocks, bonds, cash and alternative investments. The allocation should also take into consideration the personal risk profile of every investor, since risk attitudes vary from person to person.
5 - Retirement Planning: retirement planning is the process of understanding how much it costs to live at retirement, and coming up with a plan to distribute assets to meet any income shortfall.
6 - Estate Planning: involves planning for the disposition of your asset when you die. Typically, there is a tax due to the state or federal government at your death. Avoiding these taxes means that more of your assets will be distributed to your heirs. You can leave your assets to family, friends or charitable groups.